AT&T's (NYSE:T) stock has declined about 15% over the past five years, woefully underperforming the S&P 500's 50% gain over the same time frame. The telecom giant struggled with an ongoing loss of pay TV subscribers, tough competition in the wireless market, and a massive debt load from its acquisitions of DirecTV, AWS-3 spectrum licenses, and Time Warner.
AT&T's fragmented streaming efforts, a clash with an activist investor, and a CEO change also raised questions about its long-term plans. To make matters worse, the COVID-19 crisis delayed new theatrical releases from Time Warner and the production of new shows and movies.
AT&T also suffered from unfavorable comparisons to rival Verizon (NYSE:VZ), which wasn't attempting to digest one of the world's largest media companies. But despite all those challenges, AT&T remains in my portfolio for one simple reason: its big and dependable dividend.
The worst mistake AT&T investors can make right now is to ignore that dividend and solely judge the company by its stock price. Let's take a closer look at AT&T's dividend and why it still generates significant value for long-term investors.
A historically high yield with a stable payout ratio
AT&T has raised its dividend annually for 36 consecutive years, making it a "Dividend Aristocrat" of the S&P 500 -- a company that has hiked its payout for at least 25 straight years. It spent just 55% of its free cash flow (FCF) on its dividend over the past 12 months, which leaves it plenty of room for future hikes.
AT&T's forward yield currently hovers near an all-time high of about 6.8%. That's significantly higher than Verizon's 4.5% yield, and the S&P 500's average yield of about 1.9%. T-Mobile (NASDAQ:TMUS), which recently merged with Sprint, doesn't pay a dividend.
AT&T remains committed to growing its FCF even as it expands its streaming ecosystem and extinguishes its debt. Its FCF rose 30% to a record high of $29 billion in 2019, exceeding its own target of about $26 billion.
Its FCF fell 34% annually to $3.9 billion in the first quarter as the COVID-19 crisis hit its media and wireless businesses, but it still covered its $3.7 billion in dividend payments. That cash dividend payout ratio should decline significantly after the pandemic passes.
Even if AT&T's cash payout ratio temporarily exceeds 100%, it's highly unlikely it will freeze its annual dividend hikes or suspend its dividend, since it would lose its elite Dividend Aristocrat title and a large portion of its income investors. That's why it recently suspended its buybacks instead.
Believe in the power of reinvested dividends and compound returns
Investors who don't enroll their stocks in DRIPs (dividend reinvestment plan), which automatically buy more shares with the dividends they earn, likely don't understand AT&T's long-term appeal. However, reinvested dividends generate compound returns over the years, and the gap between AT&T's stock price gains and its total return price (which includes reinvested dividends) over the past 20 years is astounding:
After factoring in reinvested dividends, AT&T's 15% decline over the past five years becomes a 12% gain. Granted, AT&T's total return still trailed the market's, but its recent investments in streaming media, the growth of its WarnerMedia segment, and the potential divestments of non-core assets (like DirecTV) could bring back the bulls.
Maintain a long-term view
I didn't buy AT&T, which now accounts for nearly 5% of my portfolio, for rapid growth. Instead, I bought it for its stability and its big dividend, which will anchor my portfolio (and remind me to be patient) during market downturns.
AT&T isn't an ideal stock for investors with short investment horizons, but investors shouldn't blindly sell it while ignoring its high yield, its status as a Dividend Aristocrat, and the long-term magic of reinvested dividends and compound returns.